Uncertainty from Washington continues for states

(MCT) — WASHINGTON — As many states open their 2013 legislative sessions this month, they still don’t know how much money to expect from Washington for the coming year.

The deal that Congress and President Barack Obama reached in early January to avert the so-called “fiscal cliff” halts the most severe tax increases that were slated to take effect without an agreement. But it postpones action on spending cuts — a crucial question for states since the federal government provides about 30 percent of their revenue.

“They left uncertainty on the table,” says Michael Bird, senior federal affairs counsel at the National Conference of State Legislatures.

States will have to wait until March to find out how Congress decides to cut at least $85 billion for fiscal 2013 toward the ultimate goal of reducing spending by $2.1 trillion over 10 years. States such as Kentucky, South Dakota, Utah, Virginia and Wyoming will have already wrapped up their session by the end of March while Idaho, Maryland and Mississippi are slated to finish by early April. New York’s budget year begins April 1, whereas most state budget cycles begin July 1.

“As the sessions start, states need to put real numbers in, whether they are estimates or not,” says Scott Pattison, executive director of the National Association of State Budget Officers. He says state budget experts are asking themselves: “What do we do? What number do we pick?”

Many state leaders are relieved that the deal struck in Washington will spare them from sweeping tax changes and steep budget cuts — but that relief may be only temporary.

The package “resolved the short-term uncertainty,” says Joseph Henchman, vice president of legal and state projects at the Tax Foundation, but he says it “just doesn’t change the fact that the feds send a lot of money they don’t have to the states, and that’s likely to get pared back as the federal budget gets into balance.”

On the tax side, the package’s impact in each state depends largely on how closely the state’s tax code is tied to the federal tax code, says a report from the Pew Center on the States’ Fiscal Federalism Initiative, which explored how the fiscal cliff would affect states in a number of ways. (Stateline is also a project of the Pew Center on the States.)

A handful of states were bracing for a much bigger reduction in state tax revenue had Congress raised income taxes on everyone. Alabama, Iowa, Louisiana, Missouri, Montana and Oregon allow taxpayers to deduct their federal income taxes on their state tax returns. Higher federal taxes mean higher deductions on state tax returns, which reduce state tax revenues. But since the higher income tax applies only to individuals making more than $400,000 and families earning more than $450,000, the impact will be much less.

A handful of states also link to federal rules regarding limitations on personal exemptions and itemized deductions for higher-income taxpayers. These limitations had been temporarily suspended, but the latest package reinstates these limitations, meaning these states would see higher revenues. The states include Colorado, Minnesota, North Dakota, Oregon and Vermont.

Certain states will be affected more by the increase in the capital gains tax, the tax that people pay when they sell stock, a home or other capital assets. Under the package Congress approved, the capital gains tax will rise to 20 percent for individuals who earn more than $400,000 and stay at 15 percent for those earning below that level.

States that could see the biggest impact from this change are those that rely heavily on the income tax and have a lot of capital gains among high-income taxpayers, such as California and New York.

California has already considered the impact. A report from the California Legislative Analyst’s Office assumes that Californians will take about 20 percent of the capital gains they would have received in 2013 and move them up to 2012 so they can pay the lower federal tax rates.

The package also extends tax provisions that were set to expire, including the deduction for state and local sales tax in lieu of state income taxes and tax credits for wind energy, which a coalition of governors had pressed Congress to save.

Pete Sepp, executive vice president at the National Taxpayers Union, says it is still unclear whether states will continue to link their estate and/or inheritance taxes to the higher federal rates that are included in the budget deal.

On the spending side, states are relieved that nearly $100 billion in cuts to federal grants did not go into effect Jan. 2 as planned. If Congress hadn’t acted, federal education grants to states would have been cut by more than a $1 billion under scheduled automatic cuts, known as sequestration. States differ dramatically in their dependence on federal aid. Some 49 percent of Mississippi’s general revenue comes from Washington, for example, while federal money comprises only 24 percent of Alaska’s budget.

For some states, planned defense cuts would have had a huge impact. Federal defense spending makes up almost 15 percent of Hawaii’s total gross domestic product (GDP), compared with just 1 percent of state GDP in Oregon.

The two-month reprieve on making a decision, however, means deficit reduction and spending cuts will continue to be front and center in Washington in the coming weeks, particularly as the country once again edges closer to the federal debt ceiling.

This has state officials bracing for the possibility of more comprehensive tax reform and changes in entitlements such as Medicaid. The largest single component of total state spending, edging out K-12 education, Medicaid had been exempt from the sequestration cuts. But that could change in broader deficit reduction talks.

Advocates for the poor expect House Republicans to resurrect earlier proposals that would give states a fixed amount of Medicaid money (currently, the federal contribution is tied to the number of people who qualify for the program, rather than a set amount) or cut drastically the funding for food stamps and programs for the poor.

“We must let policymakers and opinion leaders know that it is unacceptable to reduce the deficit by targeting the most vulnerable,” writes Elizabeth Lower-Basch, a policy analyst at the Center for Law and Social Policy.

Tax policies important to states could also be on the table as part of comprehensive reform, such the preferential tax treatment the federal government gives to state and local government bonds.

But advocates of smaller government say the latest deal shows that “Washington is incapable of cutting spending,” says Tad DeHaven, a budget analyst at the Cato Institute, a conservative think tank in the nation’s capital. He says states essentially have become administrative outposts of the federal government. “Uncle Sugar will continue to tax and borrow to pay for approximately a third of total state spending,” he says.